One of the most popular trading strategies that new traders tend to use is penny stocks.
Many beginners start because they believe this is an accessible market, and the risk of failure isn’t as considerable as bigger stocks. Although there are fewer moving parts involved in penny stocks, this doesn’t make them any easier or less risky than other investments. As a result, Penny stocks are often seen as a market for only the pros. However, there are many reasons why even beginners should stay away from this type of trading.
- Wild Volatility
Penny stocks can have massive surges and dips because they lack liquidity. This means that small amounts of trades can cause significant price changes.
It’s like bumping your car into another car that’s parked on the side of the road – it may only be a light bump, but because there’s nothing to absorb the shock or distribute your vehicle’s force, this will cause a lot more damage than would otherwise be expected.
In other words, when you’re trading penny stocks and you place an order for 10,000 shares, but it only takes 30 seconds for your order to be fulfilled, this can cause a big increase or decrease in price.
- Lack of Regulation
Penny stocks are lightly regulated because they’re often found on the pink sheets. This means that they’re not listed on the New York Stock Exchange (NYSE) or NASDAQ. This also means that they don’t have to provide regular reports.
Because of this, basic information on a company might be hidden from investors. If you’re clueless about what’s going on in the business and you buy shares based on their future potential without any actual knowledge of the company itself, there’s a good chance that your investment will fail.
- Less Liquidity
More trading means a bigger chance of the stock price changing – this can mean big profits for you or huge losses. For example, if you buy a share at $1 and it goes up to $2, your profit will be $1. However, if you sell the share at $2 and the price drops down to $0.50, you’ll end up being in the hole by $1.
There have been many cases of penny stocks being manipulated. Most price changes that happen overnight are caused by someone buying or selling a vast number of shares at once while people sleep, and then prices get adjusted as the day goes on.
Most of these stocks have a small market cap and low liquidity, so it’s easy for someone with big pockets to insert themselves into the market.
- Being Scammed
Another reason you should avoid trading penny stocks if you’re a beginner is that other traders might try to scam you by promoting good penny stock picks or options, and then they’ll give you poor advice on how to buy them.
If you’re a beginner, it’s easy to be scammed by traders who want to profit from your inexperience. For example, if you’re new and don’t know an option contract or how long expiration dates work, this can be used against you.
The Better Penny Stock Strategy
Penny stocks are often promoted as the first option for beginners to start with, but this can be a costly mistake if you don’t know what you’re doing from the get-go. If someone tells you that trading penny stocks is easy and all you have to do is pick your favorite stock, think again! It’s not that simple.
Beginners should start with safer investments until they understand how things work, such as what different terms such as IPO, put options, and calls mean, or how stock prices fluctuate.
Once you’re comfortable trading in the lower price range, it will be easy to move on to more advanced trades. Although there is some potential for huge gains, beginners are better off avoiding penny stocks until they’re ready to take on the responsibility and have a better chance of success.
It’s best to remember that investing can be risky for everyone, no matter what you know. If someone tells you otherwise – run!